Week 7 post by Leslie

Merrill Lynch’s 2001 guide, “How to read financial reports,” does an admirable job orienting the amateur financial analyst as to where to find those nebulous “intangible assets” we hear so much about in today’s knowledge economy.  They’re in the “assets” section of the balance sheet, just between deferred charges and investment securities (Merrill Lynch, 2001). Yet the guide’s description of what those intangibles might include seems rather narrow. The guide mentions patents, trademarks, and copyrights as well as the territorial rights that go with some franchise agreements  (Merill Lynch, 2001) – but that’s it.

In another of this week’s readings, Christopher Allen (2002) agrees that a company must disclose “non-financial factors and intangible assets” (p. 210) to give investors a clear picture of how the company makes money, but he does not tell us what those assets might be. How frustrating! As a regular consumer of financial reports, I am keen to know what that line item actually represents for today’s “typical” firm. Allen (2002) calls for greater reporting uniformity between companies in this post-Enron era. It seems to me that a necessary first step to achieving that uniformity is cleaning out the cobwebs that shroud a company’s “intangibles.”  While our reading from The Economist (Franklin, 2008) was quite thorough in its discussion of one intangible asset, corporate social responsibility, I thought it might be useful to turn to a scholarly article for information about what else belongs in the intangibles column.

In “Disclosure of non-financial information in the annual report: A management-team perspective,” Arvidsson (2011) acknowledges the increasingly important role of intangible assets in assessing a firm’s financial health, pointing to the growing “gap between companies’ market and book value” (p. 277) as primary evidence.  He echoes Allen’s (2002) concern that financial reporting should be standardized as much as feasible (Arvidsson, 2011). To this end, Arvidsson (2011) surveyed investor relations managers (IRM) to determine what types of non-financial information are most often reported and what reasoning or incentives drive this reporting.

Arvidsson (2011) identified five categories of non-financial information that belong in the modern company’s annual report. Ranked in descending order of IRM focus, they are:   

• Organizational assets – Information related to a firm’s processes/routines, quality performance, efficiency, technology, and corporate culture
• Human assets – Information about a firm’s executive leadership, management, and/or associates and their competencies, development programs, and incentive structure
• Relational assets (external structures) – Accounting of a firm’s customers, distributors, strategic alliances, and collaborative activities
• Research and development – Information on a company’s R&D activities, patents and trademarks, idea-generation, and product portfolio
• Corporate social responsibility and environmental assets – Accounting of a firm’s community activities, environmental policies, and other CSR initiatives (Arvidsson, 2011)

Arvidsson’s (2011) study emphasizes that companies should not merely disclose these assets, but rather position intangibles in terms of their role in the company’s business strategy. We encountered a similar message in our Porter and Kramer reading (2006), which calls on companies to approach CSR selectively and with strategy in mind.

I was surprised by the relatively low importance Arvidsson’s (2011) subjects placed  on CSR reporting (Arvidsson was surprised, too, noting that the survey findings contradicted those of some earlier studies, including his own). Like Porter and Kramer (2006), Arvidsson (2011) notes that increased stakeholder interest in CSR does not necessarily translate to increased importance from a management perspective. Nonetheless, I found this more comprehensive list of what might be included in the “intangible assets” portion of a financial statement provided a missing link in my comprehension of the week’s topic.

References

Allen, C. E. (2002). Building mountains in a flat landscape: Investor relations in the post-Enron era. Corporate Communications, 7(4), 206-211.

Arvidsson, S. (2011). Disclosure of non-financial information in the annual report: A management-team perspective. Journal of Intellectual Capital, 12(2), 277-300.

Franklin, D. (2008, January 19). Just good business: A special report on corporate social responsibility. The Economist, pp. 1-14.

Merrill Lynch. (2000). How to read a financial report. Merrill Lynch, Pierce, Fenner & Smith Incorporated.

Porter, M. E., & Kramer, M. R. (2006). Strategy and society: The link between competitive advantage and corporate social responsibility. Harvard Business Review.